Tag: Anne Marie Knott

A central puzzle of corporate strategy is whether headquarters can add value to their business units beyond the burden of their own overhead. The record is bleak: On average, corporations trade at a 20% discount relative to their breakup value.

“This is the problem that we want to try fix,” said Anne Marie Knott, Olin’s Robert and Barbara Frick Professor of Business.

Anne Marie Knott

She proposed and tested a theory of how corporations could overcome that record. On November 10, she presented the findings as part of the Olin Business Research Series. More than 60 people tuned in for the virtual event.

The 20% discount could mean that multibusiness firms fundamentally destroy value or that they are poorly managed. Regardless, a whopping $5 trillion economic gain could be had from a better understanding of how headquarters add value in multibusiness firms, Knott says.

Bank One and its return on assets

Bank One, a bank holding company, motivated the theory. Knott and co-author Scott Turner, of the University of South Carolina, explain how in “An Innovation Theory of Headquarters Value in Multibusiness Firms” in Organization Science.

Bank One increased the return on assets of its target banks by 40-70%.

“This would be really easy if they were purchasing underperforming banks,” Knott said. But they weren’t. They were buying well-managed banks.

The theory relies upon dynamics between business units where laggard units improve their performance by imitating leaders. In turn, this “competition from below” stimulates leaders to innovate more.

Knott polls audience members during her Business Research Series presentation.

Beyond demonstrating that headquarters can add value through innovation and growth, the theory offers prescriptions on how to do that. For instance, they can establish systems that create norms for sharing, which eases innovation. They also can offer high-powered incentives to fuel innovation.

In general, Knott’s research examines the optimal environment and policies for innovation, which she summarizes in her book, “How Innovation Really Works” (March 2017). This interest stems from issues arising during an earlier career in defense electronics at Hughes Aircraft Company.

KEY TAKEAWAYS:

  • A $5 trillion economic gain could be had from a better understanding of how headquarters add value in multibusiness firms.
  • Bank One increased the return on assets of its target banks by 40-70%.
  • The theory relies upon dynamics between business units where laggard units improve their performance by imitating leaders.
  • In turn, this “competition from below” stimulates leaders to innovate more.




Paul Sagel seems to have violated all the presumed rules about innovation at big companies. With a swipe of gel and a strip of plastic, the Procter & Gamble research fellow created a $250 million annual line of business for company No. 45 on the 2019 Fortune 500 list.

Among business researchers, however, the conventional wisdom said Crest Whitestrips should never have happened. A nagging thread in the academic literature since the 1940s strongly suggests that the bigger a company gets, the less efficient it becomes with its investments in innovation. As they grow, firms spend more and more, yet they get less and less out of it.

Anne Marie Knott
Anne Marie Knott

Not so fast, says Olin’s Anne Marie Knott, who has a forthcoming paper in Organizational Science designed to tease apart this riddle: Why would firms engage in this seemingly irrational behavior? How can they hope to outpace the innovation in small, nimble startups that aren’t saddled with overhead and corporate inertia?

The answer to the riddle is that large companies aren’t acting irrationally. The paper, “Reconciling the Firm Size and Innovation Puzzle”—written with former Olin PhD student and current Drake University professor Carl Vieregger—concluded researchers just haven’t had the right tools to measure the productivity of investments in research and development.

Knowing the answer is vital, Knott said, because big companies remain a thriving engine of innovation and shouldn’t let conventional wisdom slow them down.

“Large firms comprise 87% of the innovation engine in this country,” said Knott, Olin’s Robert and Barbara Frick Professor of Business, citing numbers from the National Science Foundation. “They do 5.75 times more R&D than smaller firms with fewer than 500 employees—and they’re more productive with it.”

Breaking the rules

According to the conventional academic wisdom on R&D, large firms tend toward process innovation—how can we produce products more efficiently?—rather than toward new products or services. And they lean more toward incremental updates—“new and improved!”—versus new-to-the-world breakthroughs.

So Paul Sagel “broke the rules” when Procter & Gamble launched Crest Whitestrips in May 2001. The company invested years of work to introduce a revolutionary new product, disrupting cosmetic dentists’ trade in expensive tooth-whitening treatments.

In their attempt to unravel this seeming paradox, the research team took two approaches—one conclusive, the other inconclusive—and plumbed a relatively untapped source of data from the National Science Foundation’s Business R&D Innovation Survey, which has collected qualitative and quantitative data since 2008.

Two approaches

In their first approach, the researchers analyzed BRDIS data from more than 2,000 firms that invested in R&D. That analysis examined whether the apparent “small-firm advantage” stemmed from their conducting more productive forms of R&D, or whether the forms became less productive as firms got larger.

Using that approach, the team found that small firms did development (rather than research), radical innovation (rather than incremental innovation), and product innovation (rather than process innovation)—just as the prevailing theories have predicted. But the researchers found no evidence that those strategies made them more productive, or that those strategies became less productive as firms grew larger.

Then why do people think small firms are more productive? Because scholars have counted patents or products, rather than the returns from R&D.

Accordingly, in their second approach, the team tested a metric Knott has pioneered in her quest to measure the value of R&D investments: the “research quotient.” RQ is “the output elasticity of a company’s R&D”—the percentage change in revenues from a percent change in R&D. It relies  exclusively on firms’ financial data rather than unreliable and inconsistent measures such as the number of patents.

In that analysis, Knott and Vieregger found that large firms had higher RQ, no matter what form of R&D they chose. This is because large firms can exploit their size, spreading the cost of innovation across the operation. In the case of Crest Whitestrips, for example, P&G already had brand equity, distribution channels, a sales force and other assets, increasing the productivity of its investment in a new product. 

“The main takeaways are these: The idea that large firms can buy small firms to replace their own R&D is just disastrous. If we have to start rebuilding the R&D engine from scratch, it will be impossible,” Knott said. “The second is that large firms shouldn’t try to operate like small firms to become more productive—they already are more productive.”


Though the stock market is strong, company profits are stagnant—a function of a short-term focus that one Olin professor attributes to a slow-down in innovation.

In a Dec. 13 article for Harvard Business Review, Anne Marie Knott attributes the lack of innovation to three trends she uncovered through research she and her collaborators have developed.

Knott, Olin’s Robert and Barbara Frick Professor in Business, blames the “short-termism” on the trend toward companies hiring “outside” CEOs to “shake up” the organization and provide fresh insights; the decentralization of corporate research and development efforts; and a focus on “development,” rather than “research”—or, said another way, too little early-stage innovation.

In the first case, Knott argues that new, outside CEOs tend to lack the technical domain expertise to drive R&D growth. Using “RQ,” or a “research quotient,” as a measure of the return on R&D investments, Knott noted that firms with outside CEOs tended to see a decline in R&D intensity—a ratio of investment to sales—and a corresponding decline in R&D capability.

“In other words,” Knott writes, “the new leader’s disinvestment cut meat as well as fat.”

Further, by moving R&D responsibility from a central unit to separate division managers, firms separate the incentive from the result. Division managers, Knott writes, find that “their compensation is typically based on division profits (which they largely control), rather than on the company’s market value (over which they have little control).”

The result again is a reduction in the firm’s RQ quotient.

Finally, a similar problem plagues firms by lowering their tendency to invest in early-stage technologies and innovations—and for a similar reason: Division manager compensation is tied to division profits.

She cites Procter & Gamble as an example of a company that decentralized R&D from the 1990s to 2008. After a string of market-moving innovations such as the first synthetic detergent (Dreft in 1933), first fluoride toothpaste (Crest 1955), and Febreeze odor fresheners in 1998, “P&G failed to introduce a single blockbuster,” Knott writes.

Read more of Knott’s article on HBR.org.